Be Wary Of Volcano Berhad (KLSE:VOLCANO) And Its Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Volcano Berhad (KLSE:VOLCANO) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What Is It?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Volcano Berhad is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.055 = RM6.0m ÷ (RM116m - RM9.0m) (Based on the trailing twelve months to March 2024).

So, Volcano Berhad has an ROCE of 5.5%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 8.4%.

Check out our latest analysis for Volcano Berhad

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Volcano Berhad's past further, check out this free graph covering Volcano Berhad's past earnings, revenue and cash flow.

So How Is Volcano Berhad's ROCE Trending?

We weren't thrilled with the trend because Volcano Berhad's ROCE has reduced by 55% over the last five years, while the business employed 68% more capital. Usually this isn't ideal, but given Volcano Berhad conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Volcano Berhad's earnings and if they change as a result from the capital raise.

The Bottom Line

To conclude, we've found that Volcano Berhad is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 64% over the last three years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Like most companies, Volcano Berhad does come with some risks, and we've found 2 warning signs that you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.